The Hindu Business Line : Running a business is tougher than chess

"Failure is all around us. Failure is pervasive... Failure is the most fundamental feature of all systems," writes Paul Ormerod in Why Most Things Fail: Evolution, Extinction and Economics. Unhappy with the preoccupation of mainstream economi cs with `stability, order and equilibrium', Ormerod tries once again, with his new book, to coax the failing discipline out of its `intellectual inertia', by challenging theories to some reality testing, says D. Murali.

OVER the last hundreds of millions of years, 99.99 per cent of all biological species that ever existed have become extinct. In a much shorter time span too, we find many things vanishing, such as profits in the bourses, and at times even the companies in which we hold shares. Alliances snap, governments crumble, policies backfire, and diplomacy meets dead-ends.

"Failure is all around us. Failure is pervasive... Failure is the most fundamental feature of all systems," writes Paul Ormerod in Why Most Things Fail: Evolution, Extinction and Economics from Faber and Faber (www.faber.co.uk). "Fortunately, not everything fails at the same time. And sometimes we can see examples of success which persist for long periods of time." To understand success, first understand the pervasive existence of failure, he urges.

A book on failure may be the last thing you may want to read on a weekend, or any time, for that matter, and you're not alone. Existence of failure is one of the great unmentionables, acknowledges the author, and cites as example, quite ominously, how "despite decades of governmental activity to promote integration, residential areas in many western countries remain strongly segregated along racial lines".

About a decade ago, Ormerod wrote The Death of Economics to explain how human society is a living organism, not a controllable and predictable machine as viewed by conventional economics. If that, from the ex-head of the Economic Assessment Unit at The Economist, sounds unusual, in 1998 his Butterfly Economics came fluttering in, studying the complex interactions of individual parts of the economy. Unhappy with the preoccupation of mainstream economics with `stability, order and equilibrium', Ormerod tries once again, with his new book, to coax the failing discipline out of its `intellectual inertia', by challenging theories to some reality testing.

The Tyrannosaurus rex of economic activity

The book begins with `the Edwardian explosion' that started with the opening decade of the 20th century; it was responsible for setting the stage for the huge corporations, and for laying the foundations for globalisation, narrates the author. The firm is the Tyrannosaurus rex of economic activity, according to Ormerod; `a hugely successful specie', attracting outside investors' money, and with limited liability. The latter feature has contributed positively by reducing risk, notes the author. However, a distortion has been in the form of managers who reaped `spectacular rewards for failure' with other people's money and thus indulged in `a form of corporate theft'. A table illustrates how 100 companies which were the cream of capitalism in 1912, dwindled to a meagre 19 by 1995.

Nearly half (48) disappeared. An industry-specific example in the book is that between 1900 and 1920 there were almost 2,000 firms involved in automobile production in the US, but "over 99 per cent disappeared."

The iron curtain

A separate chapter looks at `a formula for failure', and it begins with an interesting quote of P.J. O'Rourke: "Microeconomics concerns things that economists are specifically wrong about, while macroeconomics concerns things economists are wrong about generally." Ormerod gels with that thought and says that a theory based on describing what the economy is like once it reaches an equilibrium, a static solution, will give us at best only a partial understanding of the world.

Business isn't as easy as economics textbooks pretend it is, cautions the author. Running an enterprise is `enormously complicated and massively uncertain', and most businesses simply don't have the capacity to process information and turn it into knowledge, he points out. "The uncertainty that shrouds the future is not so much a veil as an iron curtain."

To control any system you must be able to do two things, advises the author: "First, make forecasts which are reasonably accurate in a systematic way over time; and second, understand with reasonable accuracy the effect of changes in policy on the system." Instead of a focus on these, policy makers look for more data, as if that would help.

The author weans you from such thinking, because he is of the view that the historical data we have is "dominated by noise rather than by signal". No matter how hard we try, no matter how many statistics we collect, there are strict limits to the value of the genuine information we can extract, he declares.

`Making sense of segregation' is a particularly important chapter, after the recent racial dust that Katrina kicked up. "Attempts to promote social integration, whether along class or racial lines, have largely failed," observes Ormerod. Most people may not feel strongly about the issues, and may be happy to be integrated; yet by an `unconscious tacit agreement' this does not happen, notes the author, citing other relevant research.

Saw-tooth graphs

One of the first lessons in economics is about demand and supply, and their curves. So easily drawn in a theoretical diagram, the author comments, assuming that d and s are continuous, without any breaks. They aren't, he'd add, because "in reality, prices do not take just any value." The curve is not a smooth one but looks a bit more like a saw-tooth, with gaps, he points out.

Markets clearly work in practice, and work in general to the benefit of humanity, Ormerod assures. Only, "We do not understand why markets work as they do," he adds, citing a quote of Nobel laureate Vernon Smith.

The author draws insight from chess grandmasters who, instead of futilely searching for the best possible move, use their skill and experience to make what they consider to a reasonable one. "They make moves that seem good and that avoid obvious loss." Likewise, the economics of the 21st century is to look for reasonably good strategies, explains Ormerod. Why? Because: One, "individuals, firms, governments, households may lack access to complete information." Two, they don't have the cognitive ability to process it and find the `single, optimal choice'. And three, finding the best move is `simply too hard' when your decisions have consequences in the future.

Best-laid plans

Running a business or government is tougher than chess, says the author in a chapter titled `The Best-Laid Schemes... ', with a line borrowed from Robert Burns's poem: `The best-laid plans of mice and men often go awry'. I

n chess, you have but one opponent who doesn't change during the game, but no so in business, where "it is not always obvious who the competition is". Again, unlike chess where the goal is to win by checkmating the opponent's king, goals of business or government are multiple and often conflicting too.

The author engages the reader with snatches of research and literature, well interspersed. For instance, in a chapter titled `Doves and Hawks', he cites the work of Vito Volterra, A Mathematical Theory of the Struggle for Life based on his study of movements in fish population in the Atlantic. A few pages later, you can catch a glimpse of Evelyn Waugh's Decline and Fall, where "the hero, though blameless, through a series of unfortunate accidents finds himself expelled from the University of Oxford" and meets a true monster, Captain Grimes! Catch up with H. G. Wells's The Country of the Blind too, to know what can be learnt from an explorer who finds "an oasis of civilisation in a virtually impenetrable valley" and all its inhabitants are blind.

Dramatic simplification by traditional economists

To see `patterns in the dark', the author goes on fossil tours and studies gene structures. "The fact that evolution takes place at random might suggest that we cannot discern any patterns in its history," he notes. Yet there is a very distinct pattern in the falls of dice or winning lottery numbers, adds Ormerod. There are, therefore, charts showing extinction of species and of firms that vanished.

Different investors hold different views and that is the rationale for the market's existence, argues the author. "Bizarrely, a great deal of conventional economic theory assumes away the very differences of opinion which are such an integral feature of the real world," he points out.

It may surprise you as `dramatic simplification' that traditional economics relies on the so-called `representative agent' — "a single actor who calculates coolly and rationally the decision which will maximise his or her self-interest from now until the end of time." The trouble is, such an agent doesn't exist.

The message that the book wishes to drill into the head of every decision-maker is that `intent is not the same as outcome' because our ability to understand dynamic environments is inherently limited. To survive, the strategy that Ormerod outlines is simple: `innovate', rather than accumulate. A reasonably good strategy, if I may propose, is to read this without fail.

Economics@TheHindu.co.in

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